According to Freddie Mac, the current average interest rate on a 30-year fixed-rate mortgage is 5.3%, after topping at 5.81% on June 23. Despite dropping a bit since the third week of June, mortgage interest rates are at their highest levels since 2009, only worsening the current affordability crisis. This article will discuss five main ways homebuyers can lower their borrowing costs, as even a slight reduction in interest payments can save copious amounts of money in the long run.
1. Make a Bigger Down Payment
Making a more significant down payment isn’t always realistic, but putting down more than the traditional 20% is one of the best ways homebuyers can reduce borrowing costs. Spending a large portion of money upfront is only an option for buyers who have the means to do so, as tapping into financial reserves isn’t always a great idea. However, a larger down payment leaves the lender with less risk, meaning they usually feel more comfortable offering a lower interest rate.
Additionally, paying off a higher amount of the purchase price in the beginning means homebuyers receive a lower monthly mortgage payment. They can therefore spend more of their funds on other homeownership costs or put a larger amount toward their mortgage payments and pay off the loan in a faster timeline.
Homebuyers who can’t meet the 20% down threshold may have to buy mortgage insurance to balance out risks to lenders. While you might be able to secure a slightly lower interest rate when purchasing mortgage insurance, the insurance cost would likely negate the lower interest payment, leading to higher borrowing costs.
> Learn more: What Is Loan to Value Ratio
2. Choose a Shorter Loan Term
Choosing a shorter loan term is arguably the best way to reduce mortgage interest rates. Shorter-term mortgages typically have lower interest rates because of reduced risk to lenders, as they are likely to receive their money in a shorter amount than a 30-year mortgage. Freddie Mac’s most recent numbers show that the average interest on a 30-year fixed-rate mortgage is 5.3%, but the average interest on a 15-year fixed-rate loan is 4.75%. Someone who acquires a loan with a 5-year term can expect an even lower interest rate, averaging around 4.31%.
Since homeowners pay off a loan with a shorter interest rate sooner than they would on a 30-year term, monthly payments will be higher. Therefore, only borrowers with enough income or money in their savings can get approved for a shorter-term loan. Homebuyers can acquire a mortgage with a 20, 15, or even 5-year term. Their loan term length depends on how much they can afford to pay each month. Borrowers should plan to spend a higher amount of their monthly income toward their mortgage and understand that they may not be able to allocate as many funds to other costs of homeownership. Therefore, they should only decide to move forward with a shorter loan term if they are confident they can afford the monthly payments and still have savings for repairs and maintenance.
3. Work on Your Credit Score
A poor credit score will usually lead to a higher interest rate. Consumers can typically raise their credit score within months and request a rescore from their lender to update their credit score quickly and then present that new score to the lender.
Generally, a homebuyer will know several months ahead if they want to purchase a property. Therefore, they can use that time to work on their credit score by repaying outstanding debt, disputing any errors, apply for any additional credit cards which help build credit. A higher credit score will help secure a lower interest rate on a loan and prove to lenders that you have a history of paying back your debt promptly.
Prospective homebuyers who don’t have enough credit to qualify for a mortgage or a satisfactory interest rate can consider the growing rent-to-own market.
Those with a high credit score can also try asking lenders for a lower interest rate. Since banks want to work with homebuyers who have higher credit scores, homebuyers can use this to their advantage and showcase that their score makes them a strong customer. Sometimes, lenders just might lower their rate if you can prove you’re a competitive applicant.
4. Buy Down the Interest With Mortgage Points
A borrower can purchase mortgage points from a lender for a lower interest rate. Points typically cost 1 percent of the mortgage amount — one point on a $500,000 loan would be $5,000, for example. Each point lowers the mortgage interest rate by 0.25 percent for the loan’s lifetime. A realtor or a financial professional could help you decide if this option is right for you, as it does require investing more money upfront, and borrowers need to decide if that initial investment pays off financially.
Homebuyers can purchase multiple mortgage points and half points and must provide the funds at closing. Buying mortgage points is an effective way to prepay part of the mortgage and lower the amount of money you will spend over the loan term.
5. Shop Around for the Best Rate
Before closing on a mortgage, homebuyers should compare rates from various banks and lenders. Multiple offers allow borrowers to choose the best terms and lowest interest rate. Consider reaching out to banks or credit unions you have worked with in the past, as they may reward your loyalty with a lower rate. Homebuyers can consult a mortgage broker to find rates from multiple lenders. If a potential borrower wants to work with a specific lender, they can acquire lower price quotes from various lenders and try to present that number to their preferred lender. There is a chance that lenders could price-match to ensure they get the customer.
The easiest way to get an initial estimated interest rate on your mortgage is by checking current mortgage and refinance rates.
> Learn more: How to Find the Best Mortgage Rate
Homebuyers have several options to help secure a lower interest rate on their mortgage. With mortgage rates averaging around 5.3%, homebuyers with lower interest rates obtain more purchasing power and can therefore afford to purchase a higher value piece of property. Despite a homebuyer’s financial situation, we recommend shopping around for the most attractive interest rates.